Are Government IT Stocks a Buy Right Now?

Government information technology (IT) companies -- businesses that manage networks and provide other services for the Pentagon and civil agencies -- are an underappreciated part of the market. But at a time when valuations look stretched in a lot of sectors, it may be the right moment to give these businesses a look.

On this clip from Motley Fool Live, recorded on June 10, Motley Fool contributor Lou Whiteman talks with "Industry Focus" host Nick Sciple about the sector and why investors have been worried about what lies ahead for these businesses.

Nick Sciple: Along those lines of other companies that are plugging into that market. MS regular asks, "Any thoughts on companies that provide technology services/support to defense companies that are poised to succeed in the future" You mentioned in this portion of the market that Palantir (PLTR -0.23%) isn't going after that is a segment of the market. Any companies there that you find interesting or can you just tell us about that sector in a broad sense?

Lou Whiteman: Yes. Government IT, government services, I link it in with defense contractors because their core competency it's a very different customer being able to deal with the government versus being able to sell to the commercial or consumer. It's just a very different thing and that is the core competency. For the most part, for various reasons, these are separate companies. Now General Dynamics (GD -3.97%) is kind of alone among the huge defense titans that has an IT arm, but you have, I mentioned Leidos Holdings (NYSE: LDOS), Booz Allen Hamilton (BAH -1.08%), ManTech (MANT), CACI (CACI -0.80%), SAIC (NYSE: SAIC), a lot of other smaller companies. They were the real casualties the last time to budget fell apart, and this was in the Obama Administration with sequestration when it was a split government. One thing I found is the government is very very good at not making the same mistake twice. The era in which we neglected government IT spending was also the era of Edward Snowden and a lot of those things and not that it was a one-to-one, but that's not forgotten. I am quite confident that in this environment, with all the talk of cybersecurity right now, these businesses are going to hold up very well whatever happens with the budget. I do think because of what happened last time, the valuations have been hit. You have some best in breeds, Leidos does a lot of the hardware and brains too, so it's a neat portfolio. Booz Allen Hamilton is a consultant model which tends to be higher margins, which is interesting. ManTech, you have a lot of optionality, with an aging founder... I think they're going to buy or sell something at some point and it could be a sale. These are really underappreciated businesses that fly under the radar and I think both the budget environment and just current events tells me we're not going to see these neglected like they were eight, 10 years ago, and I really like the sector. I've done a lot of investing in that sector in the last year or so.

Sciple: I know when we did our defense basket, probably 7-8 months ago now, Booz Allen Hamilton was on that list. Is that's still your favorite of that group?

Whiteman: Probably as a pure play. I really like the optionality with Leidos because you do have autonomous ships. You have the Dynetics space business, some of the things, I mean, they have a program, you can Google it, called Gremlins, which is basically imagine a C-130 airplane acting as an aircraft carrier launching just a swarm of drones off the back. It's sci-fi stuff. They do a lot of that stuff and most of the won't work out, some of it will. That's a really neat portfolio. But yeah, Booz Allen Hamilton, you can't go wrong. I like ManTech over CACI or SAIC, but SAIC is a tempting one too. I think it's an interesting market to look at the valuations because they tend to... there's a good reason, some industries, the companies shouldn't trade in line with each other, with these businesses you do see that. You never want to invest because of M&A. But this is a business where sometimes the biggest obstacle to growth is it can take a year plus to get security clearances for new employees. Acquisitions are really attractive way to add to your cleared employees, so you do tend to see a lot of consolidation too, and business we're frankly just scale matters. There's a lot of ways to win with these guys. I think it's a neat part of the economy to go fishing right now, especially with where valuations are in other areas.